Dear Mr. Berko: In June 2010, you advised me to buy 2,000 shares of Prospect Capital, which paid 13.3 percent, at $10.47 for "speculative income," and I did. Well, in the past four years, the stock hasn't done anything, and now the company is being sued by lawyers who claim that management has misstated its earnings. Is this true? I'm disappointed Prospect Capital hasn't done anything. I'm tired of holding the stock but thankful I have only a small loss. This is just a small portion of my portfolio, and now my broker thinks I should sell this issue. He recommends three business development companies (enclosed), which have a high payout and a better possibility of increasing in value. I'd like your thoughts on them and Prospect Capital.
— FH, Punta Gorda, Fla.
Dear FH: The issues your broker recommended are so absurd I'd be embarrassed to mention their names in this column. That you would consider them as an investment possibility gives me great concern for your sanity, and that this brokster would recommend such jetsam gives me concern for your financial future.
But no, no and a thousand times no, don't sell your Prospect Capital (PSEC-$10.73). This is one of some 89 publicly traded business development companies created by Congress since 1980 to encourage the flow of public equity capital to private businesses. BDCs are unique because they focus on investing in private companies but enjoy the liquidity of a publicly traded stock. Private company investing is usually the provenance of sophisticated investors and large institutions. But BDCs provide the hoi polloi the same opportunity on a pooled basis and diversify their risks. For instance, PSEC's portfolio owns the debt and equity of 127 different companies, so if one of them were to go toes up, it would have a minimal effect on the bottom line.
The legal brouhaha to which you refer is a result of PSEC's earnings release last May. Management disclosed, in discussions with the Securities and Exchange Commission, that it may need to consolidate some of the holding companies it owns. This mention of the SEC created a potential Golconda for sleazy law firms and dime-store lawyers who'd sue their firstborn to earn a fee. So they descended on Prospect in a legal gangbang, offering to represent shareholders and claiming that management was disingenuous and misleading investors. Though they couldn't have been more wrong, PSEC collapsed anyway to $9.17 last May.
Today's price is barely different from your basis in 2010, but you've received over 13 percent yearly from those dividends, which increased fractionally every month since you've owned the stock. That's a good return, especially since only a portion of the dividend is taxable at ordinary rates.
This Maryland company provides capital to middle-market businesses for refinancing, leveraged buyouts, acquisitions, late-stage growth, recapitalization and capital expenditures. PSEC came public in late 2004 at $15 with lots of hope and minuscule revenues. For the 12 months ending in June, revenues were $700 million, while net income came in at $330 million. And Wall Street believes that next year, PSEC will report even higher revenues, earnings and dividends. So with the exception of 2010, when net margins and return on assets fell, PSEC has been a good "speculative income" issue; a return of over 13 percent annually is nothing to cough about. I think PSEC's excellent management can continue to make the company an excellent speculative income issue, and the analysts who cover this issue for Wells Fargo, RBC Capital Markets, Raymond James, Barclays, UBS and Deutsche Bank agree.
Finally, because of your broker's three recommendations, because he recommended the sale of PSEC and because 2,000 shares of this stock are a "small portion" of your portfolio, I urge you to seek an independent portfolio review. It may be time to change your financial adviser.
Malcolm Berko addresses questions about stocks. Reach him at P.O. Box 8303, Largo, FL 33775 or firstname.lastname@example.org.